Hedge Funds Fret About Proposed Rules

Date: Monday, March 30, 2009
Author: New York Times

For years, hedge fund managers in the United States have worried that their loosely regulated and secretive industry would one day face tougher regulations. Now that day seems to be here.

“It was inevitable that this would happen,” Brad Alford, founder of Alpha Capital Management, an advisory firm that invests in hedge funds, told Reuters. “From the time Congress had the industry’s top hedge fund managers testify late last year, we knew something was coming.”

But exactly what that something will be remains unclear, managers, their lawyers and investors told Reuters on Thursday hours after the Obama administration said it plans to press for broad reforms to curb risk taking on Wall Street.

“People want a road map and some clarity,” Mr. Alford told the news service.

All agreed that putting hedge funds on a tighter leash will add new nervousness to an industry already facing poor returns, struggling with redemptions and being blamed for a financial crisis its managers say they did not cause, Reuters said.

Specifically, many hedge fund managers and their lawyers fear that public outrage over enormous bonuses paid to executives at the nearly failed American International Group plus news of hefty paychecks at hedge fund firms could prompt lawmakers to try to impose unduly harsh rules.

“There is a concern that you will end up with ill-fitting regulations,” Elizabeth Shea Fries, who works with hedge funds as a partner at the law firm Goodwin Procter, told Reuters.

The private equity industry also voiced concern, saying the proposal “for the first time would impose potentially significant regulation on the private equity industry.”

“We believe that private equity investments do not create systemic risk,” Douglas Lowenstein, president of industry group the Private Equity Council, said in a statement.

“Private equity firms invest in companies, not exotic securities, and their investors are long-term investors, eliminating the ‘run on the bank’ type of risk that helped create the current financial crisis,” Mr. Lowenstein said.

He said the P.E.C. aimed to work with the government to ensure that any legislation enacted wouldn’t impose “undue burdens on private equity firms.”

Hedge fund managers are especially fearful they may have to publicly disclose short positions. Short-selling is a tool that is off-limits at most funds but helps hedge funds make money in declining markets.

Similarly, they worry that regulators may favor certain players — for example, proprietary traders at banks — while imposing new rules on hedge funds.

And they worry that a new regulatory regime, particularly with someone charged with overseeing systemic risk, might be murky and possibly even redundant.

Already state lawmakers and regulators, including some in Connecticut where thousands of hedge funds operate, are pursuing their own forms of regulation.

“How may people do I have to allow to come through my front door demanding a look at my books?” one Boston-based hedge fund manager, who asked not to be identified for fear of angering regulators who might eventually audit his business, complained to Reuters.

But lawyers also said they are pleased to see the Treasury Department and Securities and Exchange Commission involved in shaping new rules because it gives them comfort that any regulation would be better conceived and more workable than if lawmakers put it together.

“That is where the regulators’ participation in this is very useful,” Ms. Fries of Goodwin Procter told Reuters.

Among all of the swirling questions, one thing seems fairly certain: Managers of large pools of capital, like hedge funds and private equity funds, will be asked to supply more information about themselves to regulators. Registration was briefly required for some hedge funds a few years ago before being ended following a lawsuit.

For small funds this is an especially expensive proposition.

“I half expect to have to do it [register], but it is a real expense overload for small funds in actually doing it,” Thomas Grossman, principal at hedge fund Union Avenue Advisors, said at this week’s Reuters Private Equity and Hedge Funds Summit.

Still, tumbling markets and anxiety on Wall Street and Main Street will probably make registration stick.

“Registration and disclosure would seem entirely appropriate in this financial environment,” Donald Gogel, president and chief executive officer of private equity firm Clayton, Dubilier & Rice, told Reuters on the sidelines of a conference.